ANDERSON v. STONEMOR PARTNERS, L.P. et al

Filing 87

MEMORANDUM. SIGNED BY HONORABLE EDUARDO C. ROBRENO ON 10/31/17. 10/31/17 ENTERED AND COPIES E-MAILED.(rv)

IN THE UNITED STATES DISTRICT COURT
FOR THE EASTERN DISTRICT OF PENNSYLVANIA
JUDSON ANDERSON, et al.,
Plaintiffs,
v.
STONEMOR PARTNERS, L.P., et al.,
Defendants.

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CIVIL ACTION
NO. 16-6111

M E M O R A N D U M
EDUARDO C. ROBRENO, J.

October 31, 2017

This is a consolidated class action arising out of
Plaintiffs’ purchase of common units1 in StoneMor, L.P.
(“StoneMor”) which provides funeral and cemetery services and
products. Defendants include StoneMor; StoneMor G.P.; StoneMor
GP’s parent company, American Cemeteries Infrastructure
Investors, LLC (“ACII”); and the controlling shareholderexecutives (“Defendants”). CAC ¶ 25-37, ECF No. 67. Plaintiffs
are investors who purchased common units of StoneMor between
March 15, 2012 and October 27, 2016 (the “Class Period”). Id. at
1. The Amended Complaint contains two counts. Count One alleges
violations of Section 10(b) of the Securities Exchange Act and
1

StoneMor is a master limited partnership which publicly trades
securities referred to as “units.” CAC ¶ 26, ECF No. 67. These
units are traded similarly to shares of stock.

SEC Rule 10(b)5 promulgated thereunder. Id. at 101. Count Two
alleges violations of Section 20(a) of the Securities Exchange
Act. Id. at 102.
On February 21, 2017, the Court appointed Fremont
Investor Group (“FIG”) as lead counsel, and approved FIG’s
selection of counsel. ECF No. 64. On April 24, 2017, FIG filed
an amended consolidated class action complaint (“Complaint”).
ECF No. 67. On June 8, 2017, Defendants moved to dismiss. ECF
No. 68. For the reasons that follow, the Court will grant the
motion to dismiss.

I.

FACTUAL BACKGROUND AND PROCEDURAL HISTORY
Plaintiff alleges the following facts, all of which

are presumed to be true for purposes of resolving the motion to
dismiss. During the Class Period, Defendants issued materially
false and misleading statements regarding its business and
financial performance. Id. at ¶¶ 130-31, 136, 209-10. The
alleged purpose of these statements was to create the appearance
that Defendants were economically able to meet “their primary
corporate purpose: the regular, quarterly distribution” of
available cash to investors. Id. at ¶ 1 (emphasis in original).
Plaintiffs claim that, unbeknownst to investors, StoneMor was
actually “severely cash-strapped” during the Class Period, and
only able to pay its generous distributions through “an

2

elaborate financial ruse.” Id. at ¶ 2. In essence, the “ruse”
was that StoneMor paid the distributions from its revolving
credit facility, which in turn was paid down through the
proceeds from a series of equity offerings. Id.
Plaintiffs argue that they were misled into believing
that the primary source of distribution funds was “operating
cash flow,” when, in reality, cash to fund distributions was
“almost entirely dependent” on StoneMor’s “ability to sell
equity in the capital markets.” Id. at ¶¶ 1-2. StoneMor’s
business plan was to aggressively acquire cemeteries and
immediately build a “pre-need” sales program by selling to
customers who are still alive, but want to pre-arrange their own
funeral arrangements. Id. at ¶ 11. However, state law requires
that the majority of the total pre-need sales proceeds be kept
in trust until the actual burial services are performed. Id.
Thus, StoneMor could not access most of the cash from
pre-need sales until after the customer died. Id. Because preneed sales were such a large portion of StoneMor’s business
strategy, the inaccessibility of cash from them created a
substantial disparity between overall sales and actual incoming
cash. Id. at ¶ 12. Under GAAP2 principles, cash from pre-need
sales would not be represented as assessable cash. Id. at ¶ 11.
However, StoneMor did not rely solely on GAAP metrics to court
2

Generally Accepted Accounting Principles.
3

See id. at ¶ 2.

investors. Id. at ¶ 12. Instead, StoneMor also presented
investors with non-GAAP figures it had created, which showed
sales and costs for each period, but did not subtract the cash
in trust. Id. at ¶¶ 3, 7, 11-12, 14. According to the
Plaintiffs, the difference between the actual available cash and
the non-GAAP measures of apparently available cash (that was
still in trust) was unknown to investors. Id. at ¶ 14.
Plaintiffs further claim that the difference between the GAAP
and non-GAAP measures “intentionally gave the impression that
StoneMor was generating sufficient operating cash flow to
justify . . . the cash distributions” and concealed the
“material divergence between the cash distribution payments and
the amount and timing of revenue and cash flows generated from
operations.” Id. at ¶ 14, 69. But, accurate GAAP measurements
consistently appeared alongside the non-GAAP ones. Id. at ¶ 69.
Next, Plaintiffs allege that StoneMor’s financial
“house of cards” came down when StoneMor issued corrective
disclosures concerning previously publically-filed financial
statements. Id. at ¶¶ 17-19. The corrections stated that recent
auditing had revealed “material weaknesses” in certain sets of
internal controls. Id. at ¶ 198. This curtailed StoneMor’s
access to capital markets, which caused StoneMor to cut its
distribution by approximately half. Id. at ¶¶ 201-06. Plaintiffs
claim that because StoneMor slashed its distribution, StoneMor’s
4

unit price dropped by almost forty-five percent. Id. at ¶¶ 202204.
In sum, Plaintiffs allege that Defendants concealed
how StoneMor’s distributions were, indirectly, funded with the
use of debt/equity, which allegedly concealed the risk that
distributions would be cut significantly if StoneMor’s access to
the capital markets was ever impaired. Id. at ¶¶ 136, 166. The
allegedly false and misleading statements can be broken down
into four categories:

Category A: Statements lauding StoneMor’s strength or
health in connection with a particular quarter’s
distribution announcement;
Category B: Statements regarding the connection
between operations and distributions;
Category C: Statements that equity offerings were used
to pay down StoneMor’s debt facility; and
Category D: Certification statements required by
statute.

Defendants now move to dismiss the Complaint, pursuant
to Federal Rule of Civil Procedure 12(b)(6), and the heightened
pleading standard of the Private Securities Litigation Reform
Act (“PSLRA”).

5

II.

LEGAL STANDARD
A party may move to dismiss a complaint for failure to

state a claim upon which relief can be granted.
12(b)(6).

Fed. R. Civ. P.

When considering such a motion, the Court must

“accept as true all allegations in the complaint and all
reasonable inferences that can be drawn therefrom, and view them
in the light most favorable to the non-moving party.”
DeBenedictis v. Merrill Lynch & Co., 492 F.3d 209, 215 (3d Cir.
2007) (quoting Rocks v. City of Phila., 868 F.2d 644, 645 (3d
Cir. 1989)).

To withstand a motion to dismiss, the complaint’s

“[f]actual allegations must be enough to raise a right to relief
above the speculative level.”
U.S. 544, 555 (2007).

Bell Atl. Corp. v. Twombly, 550

This “requires more than labels and

conclusions, and a formulaic recitation of the elements of a
cause of action will not do.” Id.

Although a plaintiff is

entitled to all reasonable inferences from the facts alleged, a
plaintiff’s legal conclusions are not entitled to deference and
the Court is “not bound to accept as true a legal conclusion
couched as a factual allegation.”

Papasan v. Allain, 478 U.S.

265, 286 (1986).
The pleadings must contain sufficient factual
allegations so as to state a facially plausible claim for
relief.

See, e.g., Gelman v. State Farm Mut. Auto. Ins. Co.,

583 F.3d 187, 190 (3d Cir. 2009).
6

“A claim has facial

plausibility when the plaintiff pleads factual content that
allows the court to draw the reasonable inference that the
defendant is liable for the misconduct alleged.”
Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)).

Id. (quoting

In deciding a

Rule 12(b)(6) motion, the Court limits its inquiry to the facts
alleged in the complaint and its attachments, matters of public
record, and undisputedly authentic documents if the
complainant’s claims are based upon these documents.

See Jordan

v. Fox, Rothschild, O’Brien & Frankel, 20 F.3d 1250, 1261 (3d
Cir. 1994); Pension Benefit Guar. Corp. v. White Consol. Indus.,
Inc., 998 F.2d 1192, 1196 (3d Cir. 1993).

III.

DISCUSSION
Plaintiffs allege that Defendants made or failed to

make statements in violation of Section 10(b) of the Securities
Exchange Act of 1934, codified as amended at 15 U.S.C. § 78j(b),
and Rule 10b–5, 17 C.F.R. § 240.10b–5. To state a claim for
relief under section 10(b), a plaintiff must plead facts
demonstrating that (1) the defendant made a materially false or
misleading statement or omitted to state a material fact
necessary to make a statement not misleading; (2) the defendant
acted with scienter; and (3) the plaintiff's reliance on the
defendant's misstatement caused him or her injury. Cal. Pub.
Emps.’ Ret. Sys. v. Chubb Corp., 394 F.3d 126, 143 (3d Cir.
7

2004). Claims brought under Section 10(b) and Rule 10b–5 must
meet the heightened pleading requirements of Fed. R. Civ. P.
9(b) and the specific requirements of 15 U.S.C. § 78u–4(b),
which is a portion of the PSLRA. Congress adopted these
stringent pleading standards as “a check against abusive
litigation,” recognizing that “[p]rivate securities fraud

actions. . . can be employed abusively to impose substantial
costs on companies and individuals whose conduct conforms to the
law.” Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S.
308, 313 (2007).
The PSLRA “imposes two exacting and distinct pleading
requirements.” In re Aetna, Inc. Sec. Litig., 617 F.3d 272, 277
(3d Cir. 2010). First, with respect to false and misleading
statements, a complaint must “specify each statement alleged to
have been misleading, the reason or reasons why the statement is
misleading, and, if an allegation . . . is made on information
and belief . . . state with particularity all facts on which
that belief is formed.” Id. (citing 15 U.S.C. § 78u-4(b)(1)).
Second, the PSLRA also enhances the requirements of Fed. R. Civ.

P. 9(b) and requires the complaint to “state with particularity
facts giving rise to a strong inference that the defendant acted
with the required state of mind.” Id. at 277 (citing 15 U.S.C. §
78u-4(b)(2)). A strong inference of scienter “must be more than
merely plausible or reasonable – it must be cogent and at least
8

as compelling as any opposing inference of nonfraudulent
intent.” Tellabs, 551 U.S. at 309. A court must consider
“whether all of the facts alleged, taken collectively, give rise
to a strong inference of scienter, not whether any individual
allegation, scrutinized in isolation, meets that standard.”
Instit’l Inv. Grp. v. Avaya, 564 F.3d 242, 267-68 (3d Cir.

2009)(quoting Tellabs, 551 U.S. at 321).
A. False or Misleading Statements
The first issue is whether the statements alleged
were, in fact, false or misleading. “A statement is false or
misleading if it is factually inaccurate, or additional
information is required to clarify it.” Wallace v. Sys. &

Comput. Tech. Corp., No. 95-6303, 1997 WL 602808, at *9 (E.D.
Pa. Sept. 23, 1997). Further, the failure to disclose a fact can
also lead to liability under Rule 10b–5 “where silence would
make other statements misleading or false.” Id. In order to
state a claim, then, plaintiffs must allege the existence of
some fact, known to defendants at the time of the statements,
the disclosure of which would have made the statement clearer or
more correct. In re Discovery Labs. Sec. Litig., No. 06-1820,
2006 WL 3227767, at *9 (E.D. Pa. Nov. 1, 2006). They must also
demonstrate that, without the undisclosed fact, a reasonable
investor was likely to be misled by the statement. Id. It is not

9

enough simply to show that there is additional information
defendants could have provided that would have made the
statement clearer. Id. Plaintiffs must also show that, in the
absence of that clarification, there was a substantial danger
that reasonable investors would be misled. Id.
1.

Category A Statements

Starting with the statements in Category A, Plaintiffs
focus on statements in StoneMor’s distribution announcements
that it was performing well. See CAC ¶¶ 128, 133, 137-38, 141,
145, 150, 153, 167, 174, 178, ECF No. 67. These statements laud
the “strong performance of [StoneMor’s] base operations” and
“continued strength in revenue growth and distributable free
cash flow [that] allowed [StoneMor] to increase []
distribution.” Id. at ¶¶ 167, 178. Defendants argue that these
statements are “generalized ‘positive portrayals’” and thus not
actionable under federal securities laws. Def. Mot. at 20, ECF
No. 68-2. It is well-settled that “vague and general statements
of optimism constitute no more than ‘puffery’ and are understood
by reasonable investors as such.”

In re Advanta Corp. Sec.

Litig., 180 F.3d 525, 538 (3d Cir. 1999) (overruled on other
grounds by Tellabs, 551 U.S. 308) (quoting In re Burlington Coat
Factory Sec. Litig., 114 F.3d 1410, 1428 n. 14 (3d Cir. 1997).
However, portions of the Category A statements go beyond

10

“puffery.” Mainly, one StoneMor press release stated, “We
determine the distribution based on the operation performance of
the company and the resultant Available Cash at the end of the
quarter. . .”. CAC ¶ 137, EFC No. 67. The plain language of this
statement goes beyond an unactionable statement of optimism,
because it purports to state actual facts regarding how StoneMor

funded distributions. Because Plaintiffs allege that StoneMor
actually relied on equity proceeds to fund the distributions,
(rather than operation performance) and its ability to do so was
“almost entirely dependent on its ability to sell equity in the
capital markets,” (thus arguably not on “Available Cash”) these
statements are arguably false or misleading as plead. Pl. Resp.
to Def. Mot. at 2, 19, ECF No. 74. Therefore, some of the
Category A statements are at least arguably false or misleading.
2.

Category B Statements

The Category B statements pertain to the connection
between StoneMor’s operations and distributions. StoneMor stated
to investors and analysts that “[StoneMor’s] primary source of
cash from which to pay partner distributions . . . is operating
cash flow.” CAC ¶¶ 129, 155, ECF No. 67. Further, Defendants
allegedly told investors, “you can feel comfortable that
[StoneMor] generate[s] enough cash flow to pay a distribution in
this period.” Id. at ¶ 182. Plaintiffs argue that this was

11

false, because the distributions were paid using equity sales as
opposed to operating cash, as Defendants stated. Id. at ¶ 17.
However, those statements referred to the non-GAAP earnings and
cash flows, which exceeded distributions because they included
the case from pre-need sales that were in trust. Id. at ¶¶ 11,
155, 172, 182. Further, StoneMor also disclosed that its GAAPmeasured cash flows were lower than distributions. Id. at ¶¶
3,7,9,77,87-97. Because StoneMor’s Category B statements
referred to non-GAAP metrics, and were accurate portrayals of
those metrics, they are not false. Similarly, because StoneMor
also disclosed the GAAP metrics, and disclosed that GAAP-based
operating revenues and cash flows were lower than cash
distributions, the Category B statements were not misleading.
Therefore, none of the Category B statements are sufficient to
state a securities fraud claim.
3.

Category C Statements

Next, regarding the Category C statements, Plaintiffs
claim that Defendants made actionable misstatements about how
StoneMor intended to use funds from its equity offerings. See
id. at ¶¶ 143, 148, 156, 159, 162-63, 165, 170, 176, 179, 184,
186, 189, 191-92.

For example, StoneMor allegedly denied that

it paid distributions using the funds obtained from its equity
offerings. Id. at ¶¶ 191-92. But Plaintiffs do not contend that

12

StoneMor actually paid distributions directly from equity
offerings. Rather, Plaintiffs claim that these representations
were misleading because StoneMor’s equity offerings were used to
pay down its credit facility, from which it primarily funded
distributions. Id. at ¶¶ 96, 144, 148-49, 158, 160. Further,
StoneMor explicitly disclosed, on multiple occasions, that it
relied on equity offerings to pay down its credit facility,
including in each of its Form 10-Ks during the Class Period. See
Def. Exs. 4, 11, 15, 19, ECF No. 69-4. Because these statements
were literally true, and the entire picture was publically
disclosed, the Category C statements are not misleading.
4.

Category D Statements

Category D includes certain certifications made in
Defendants’ SEC filings, namely 10-Ks and 10-Qs. These
statements are part of statutorily-required certifications under
regulations promulgated under the Sarbanes-Oxley Act. See 17
C.F.R. §§ 240.13a-14. In pertinent part, these statements by
Defendants report that, based on their knowledge, the
information in the filings was accurate, and that they had
designed and evaluated internal and disclosure controls. See CAC
¶ 197, ECF No. 67. On November 9, 2016, Defendants amended the
certification they made on February 29, 2016, to state that
recent auditing had revealed “material weaknesses” in certain

13

sets of internal controls. Id. at ¶ 198. Without explanation,
Plaintiffs assert that this amounts to securities fraud.
However, “there is nothing in either the 1934 Securities
Exchange Act or the Sarbanes-Oxley Act and implementing
regulations that authorizes plaintiffs to base a claim for
securities fraud on an alleged misstatement in a Sarbanes-Oxley
certification.”

In re Silicon Storage Tech., Inc., Sec. Litig.,

No. C-05-0295PJH, 2007 WL 760535, at *17 (N.D. Cal. Mar. 9,
2007). Further, Plaintiffs do not even allege with particularity
that Defendants knew at the time of certifying that the
statements were false. Finally, when a corrective disclosure has
no impact on the price of a security, the alleged misstatement
is immaterial as a matter of law. See In re Burlington Coat
Factory, 114 F.3d at 1425. Here, Plaintiffs do not allege that
StoneMor’s unit price moved in response to either the
certifications or their correction. Rather, Plaintiffs claim
that the unit price dropped because StoneMor slashed its
distribution. CAC at ¶¶ 202-204, ECF No. 67. Therefore, the
statements in Category D are not actionable.
B. Materiality
Having established that at least some of Plaintiffs'
claims (in Category A) may allege misleading statements and
omissions, the next issue is whether they are material. The test

14

is whether the information, if disclosed, “would have been
viewed by the reasonable investor as having ‘significantly
altered the “total mix” of information’ available to that
investor.” In re Westinghouse Sec. Litig., 90 F.3d 696, 714 (3d
Cir. 1996) (quoting TSC Indus. v. Northway, Inc., 426 U.S. 438,
449 (1976)). Similarly, “[a]n omitted fact is material if there

is a ‘substantial likelihood that, under all the circumstances,
the omitted fact would have assumed actual significance in the
deliberations of the reasonable shareholder.’” Shapiro v. UJB
Fin. Corp., 964 F.2d 272, 280 n. 11 (3d Cir. 1992) (quoting TSC,
426 U.S. at 449). Because the question of materiality is
concerned with the “total mix” of information, “a statement or
omission is materially misleading only if the allegedly
undisclosed facts have not already entered the market.” Winer
Family Trust v. Queen, No. Civ. A. 03-4318, 2004 WL 2203709 at
*4 (E.D. Pa. Sept. 27, 2004).
In a securities fraud case, “a motion to dismiss may
be granted if the company’s SEC filings or other documents
disclose the very information necessary to make their public
statements not misleading.” In re Discovery Labs., 2006 WL
3227767, at *11 (citation and internal punctuation
omitted)(dismissing claims and noting that “prior public
disclosure negates a finding that material information was
withheld”). See also Ieradi v. Mylan Labs., Inc., 230 F.3d 594,
15

599 (3d Cir. 2000) (dismissing Rule 10b-5 claims where allegedly
omitted information was disclosed). Further, for purposes of the
materiality determination in securities fraud, a “‘reasonable
investor’ is neither an ostrich, hiding her head in the sand
from relevant information, nor a child, unable to understand the
facts and risks of investing.” Greenhouse v. MCG Capital Corp.,
392 F.3d 650, 656 (4th Cir. 2004).
Here, it appears that StoneMor repeatedly and clearly
disclosed the very information Plaintiffs allege was concealed
from the market. For instance, the keystone of Plaintiff’s
claims is that the alleged misstatements “obscured the fact that
the [StoneMor] paid the distribution[s] from its revolving
credit facility, which in turn was paid down through the
proceeds of a series of equity offerings.” CAC ¶ 2, ECF No. 67.
Plaintiffs claim that this “sleight of hand was furthered by
reliance on arcane, non-GAAP accounting methods,” which
purportedly obscured the fact that, under GAAP accounting,
StoneMor “actually generated only a small fraction of the
revenue needed to pay [the distributions.]” Id. at ¶¶ 3-9.
According to Plaintiffs, this “concealed [the] risk that
distributions would be cut significantly if the Company’s access
to the capital markets was ever impaired.” Id. at ¶¶ 136, 166.
However, all of this information was repeatedly disclosed.
StoneMor disclosed that its ability to pay distributions
16

depended on its revolving credit facility, which was paid down
with equity offerings. Def. Mot. Ex. 15, ECF No. 68-2. StoneMor
also disclosed its GAAP financials, as well as a reconciliation
between its GAAP and non-GAAP financials. CAC ¶ 16, ECF No. 67.
Further, StoneMor disclosed that its GAAP revenues and
operating cash flows were lower than cash distributions. Id. at
¶¶ 3,7,9,77,87-97. In addition to these disclosures, Plaintiffs
themselves state that the “truth” of the “scheme” was recognized
by investors long ago, based on publically available
information. See id. at ¶¶ 54, 89, 90-94, 112-115. Thus,
Plaintiffs essentially concede that no information was
concealed. Even if StoneMor “focused investor and analyst
attention on non-GAAP financial measures,” it contemporaneously
presented GAAP financial measures, which are not alleged to be
inaccurate or misleading. Id. ¶¶ 69, 127-200,

see also In re

Calpine Corp. Sec. Litig., 288 F. Supp. 2d 1054, 1083 (N.D. Cal.
2003) (noting that “[o]ne would expect that if the use of nonGAAP measures by itself were actionable under the Exchange Act,
corporations would have ceased using such measures a long time
ago”). Also, Plaintiffs do not allege anything false or
misleading about the reconciliation StoneMor offered between the
GAAP and non-GAAP measurements. Because StoneMor disclosed all
of the information that Plaintiffs allege it concealed, and a
reasonable investor would account for the disclosed information,
17

Plaintiffs have not sufficiently plead a material omission or
misstatement.
C. Scienter
The next requirement imposed on a Rule 10b–5 claim is
that a plaintiff must allege that a defendant acted with
scienter. Scienter is “a mental state embracing intent to
deceive, manipulate, or defraud.” Tellabs, 551 U.S. at 319.
Under the PSLRA, for each alleged misstatement, plaintiffs must
“state with particularity facts giving rise to a strong
inference” of scienter. 15 U.S.C. § 78u–4(b)(2). Plaintiffs may
create that inference by alleging facts “establishing a motive
and an opportunity to commit fraud, or by setting forth facts

that constitute circumstantial evidence of either reckless or
conscious behavior.” Advanta, 180 F.3d at 534–35 (quoting Weiner
v. Quaker Oats Co., 129 F.3d 310, 318 n. 8 (3d Cir. 1997)). It
is not enough, however, simply to allege that defendants stood
to benefit from the alleged misstatements or had the opportunity
to commit fraud. Advanta, 180 F.3d at 535. In addition,
“[m]otives that are generally possessed by most corporate
directors and officers do not suffice; instead, plaintiffs must
assert a concrete and personal benefit to the individual
defendants resulting from this fraud.” GSC Partners CDO Fund v.
Wash., 368 F.3d 228, 237 (3d Cir. 2004) (citation omitted).

18

Plaintiffs first attempt to show scienter by
enumerating the ways in which the Defendants possessed power,
insider knowledge, authority, and control over StoneMor’s public
statements, distributions, equity sales, and the use of equity
sales to indirectly fund distributions. CAC ¶¶ 209-14, ECF No.
67. Plaintiffs argue that such access and control creates a

strong inference that Defendants knew that the alleged
misstatements were false or misleading. Id. at ¶¶ 210, 214, 216.
Plaintiffs further argue that some of Defendants’ responses to
questions by analysts were evasive, suggesting scienter. Id. at
¶ 219-23. Next, Plaintiffs argue that Defendants’ knowledge can
be inferred because, under StoneMor’s partnership agreement,
Defendants received additional distributions when StoneMor
issued distributions beyond a certain threshold. Id. at ¶ 224.
Also, Plaintiffs claim that the retirement of StoneMor’s founder
- six months after the distribution was cut – as well as CFO
turnover (four CFOs or interim CFOs during the Class Period)
raise a strong inference of scienter. Id. at ¶¶ 230-32.
Additionally, plaintiffs attempt to show scienter

under a recklessness theory. In 1979, the Third Circuit adopted
the Seventh Circuit's definition of recklessness in this
context. A reckless statement is one that is “highly
unreasonable” and involves “not merely simple, or even
inexcusable negligence, but an extreme departure from the
19

standards of ordinary care, and which presents a danger of
misleading buyers or sellers that is either known to the
defendant or is so obvious that the actor must have been aware
of it.” McLean v. Alexander, 599 F.2d 1190, 1197 (3d Cir. 1979)
(quoting Sundstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033,
1045 (7th Cir. 1977)). The Tenth Circuit applied the Seventh

Circuit standard to a post-PSLRA case involving failure to
disclose allegedly material facts in City of Philadelphia v.
Fleming Companies, 264 F.3d 1245 (10th Cir. 2001). The Tenth
Circuit noted that “it is the danger of misleading buyers that
must be actually known or so obvious that any reasonable man
would be legally bound as knowing.” Id. at 1260 (emphasis in
original) (quoting Schlifke v. Seafirst Corp., 866 F.2d 935, 946
(7th Cir. 1989)). Under a recklessness theory, knowledge can be
shown by demonstrating that the fact “was so obviously material
that the defendant must have been aware both of its materiality
and that its non-disclosure would likely mislead investors.” Id.
at 1261; Wilson v. Bernstock, 195 F. Supp.2d 619, 639 (D.N.J.
2002).

As noted above, the alleged misstatements were not
material. Even if they were arguably material, the very fact
they appear immaterial demonstrates that they are not “so
obviously material” as to allow a finding of recklessness under
the standard in City of Philadelphia. 264 F.3d at 1261. See also
20

In re Discovery Labs., 2006 WL 3227767, at *14. Therefore,
Plaintiffs have failed to adequately plead scienter as the PSLRA
requires.
D. Section 20(a) Claim
In addition to their Rule 10b–5 claim, Plaintiffs also
assert violations by controlling persons under Section 20(a) of
the ′34 Act, 15 U.S.C. § 78t(a). Because a claim for controlling
person liability requires “proof of a separate underlying
violation of the Exchange Act,” Advanta, 180 F.3d at 541, and
the underlying 10-b claim fails, the Section 20(a) claim also
fails.

IV.

CONCLUSION
For the reasons stated above, the Court will grant

Defendants’ motion to dismiss as to both counts of the
Complaint.
An appropriate order follows.

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